Debt Levels are Leading These Aussie Markets to a Fall

The Reserve Bank of Australia governor speaks, the Aussie dollar climbs. Even when the governor, Philip Lowe, told parliament that ‘it would be better if it were lower still.’

It seems the market doesn’t much care for opinion, even by the RBA governor. Not when that same governor tells parliament that lowering interest rates:

‘Would mainly work to get people to borrow more. And when they borrow more that will probably push up house prices even more, because they’ll mainly be borrowing for the purposes of housing, not to fund more consumption.’

No more rate cuts, it would seem.

As you’d expect, the Aussie dollar responds by heading higher Friday — to above 77 US cents. It’s now not far from what seems to be a level of resistance just above 78 US cents.

But whether the Aussie dollar is on the verge of bursting through to new highs, or merely flitting higher before a catastrophic fall, comes down to two things.

Two things that also happen to be among our favourite topics: an Aussie recession, and an Aussie house price crash.

On the matter of a house price crash, Mr Lowe didn’t explicitly sound the alarm bells…or did he? You be the judge. Here’s what he told parliament:

‘The issue we’re discussing, internally, is how much extra fragility would that mean in the economy with household debt already at a record high. Is it really in the national interest to get a little bit more employment growth in the short run at the expense of creating vulnerabilities which would become quite dangerous in the medium term?’

Take that to mean whatever you like it to mean. But to us it’s clear: high Aussie household debt will only get worse, causing an even bigger housing bubble, if interest rates fall any lower.

Of course, the assumption seems to be that it’s not already ‘quite dangerous’, in terms of high house prices and high debt.

We’d argue that high debt levels have been ‘quite dangerous’ for quite some time.

To argue otherwise is foolish, as far as we’re concerned.

As you can see from the chart below, Australia’s household debt to GDP now stands at 104.93.

Source: Bloomberg

In other words, the size of Australia’s household debt exceeds the size of the Aussie economy!

Furthermore, when you consider that one-third of people own their home outright, and one-third rent, it means one-third of Aussies are carrying the burden of a debt pile larger than Australia’s GDP.

In that context, we’d say that the situation is ‘quite dangerous’ already.

If only we could get someone at the central bank to agree with us.

Double top

Uh-oh! Your editor isn’t the only bear when it comes to the broad Aussie market.

Bloomberg reports:

‘Stocks in Australia are close to cementing a double top trading pattern that’s considered a bearish signal for technical analysts. The S&P/ASX 200 index formed its second top late last week and has gone on to fall five of the past six days.’

Here you have it, in the chart below, marked by the red horizontal line:

Source: Bloomberg

A double top. What could it mean? Our (very) rudimentary charting analysis would say that if the market breaks downwards from this high, a fall in the region of 10%, at least, is in order.

Look out below.

Falling down?

Speaking of looking out below, more from Bloomberg:

‘Iron ore’s having a reality check as investors question whether the exuberance that lifted prices to the highest level since 2014 is entirely rational given concern about elevated stockpiles in China, rising supply and statements of caution from some of the world’s biggest miners.’

According to the report, iron ore traded on China’s Dalian Commodity Exchange was down as much as 9% from Tuesday’s high.

US dollar priced iron ore, delivered to Qingdao, China, yesterday fell more than 3% from the previous day.

Fortescue has been the big beneficiary. It’s up 218% over the past year. Due to its size, and its leveraged balance sheet, it’s not surprising that it tends to be the most volatile of the three Aussie iron ore miners.

But just as it has outperformed BHP and Rio during the current iron ore bull market rally, you know the flipside with leverage. If the analysis and fears are right about a bubble in iron ore prices, a falling iron ore price would likely mean a big fall for the Fortescue share price.

Not that this is the first time anyone has predicted bad news for Fortescue…and it won’t be the last.

Kris Sayce, dubbed the ‘Jeremy Clarkson of Australian finance’, began as a London finance broker specialising in small-cap stock analysis on London’s Alternative Investment Market (AIM). Kris then spent several years at one of Australia's leading wealth management firms. A fully accredited advisor in shares, options, warrants and foreign-exchange investments, Kris was instrumental in helping to establish the Australian version of the Markets and Money e-newsletter in 2005.
He is the Publisher, Investment Director and Editor in Chief of Australia's most outspoken financial news service, Markets & Money.

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